Peter Magliocco describes how phased retirement can allow clients extra flexibility in their retirement planning
Phased retirement is designed to allow retirees to buy annuities or transfer their pension to income drawdown in stages - rather than buying an annuity all at once on retirement. This allows the bulk of their retirement fund to remain fully invested to benefit from the potential of future growth. Such remaining funds which are unused or "unvested" can be passed on to other people without a tax charge in the event of the member's death before age 75 and are usually deemed to fall outside of the estate for inheritance tax purposes.
A phased retirement plan works by allowing parts of the pension fund to be used at different times. The retiree decides how much income they need and cashes in the amount of fund needed to generate this income. This is derived as part tax free cash and part ongoing income from either annuity purchase or income drawdown. Each time an amount is encashed the beneficiary can normally take up to 25% tax free cash.
Choosing whether to use a phased retirement plan, rather than annuitising in a single step on retirement, depends on the circumstances of the retiree, the value of their pension assets as well as their attitude to risk.
The advantages are significant. Retirees gain the flexibility to plan the income they require year by year and they can benefit from the potential of ongoing investment returns. In addition, as some of their pension fund has not been vested, some of their pension assets can be passed to their heirs if they die before the age of 75 (and potentially older if they opt for an alternatively secured pension (ASP).
Given the variation in investment returns over time and the changing income needs of a retiree a regular review of the plan and its performance is essential. This ensures that the plan holder is not drawing too much income too soon, especially if investment returns are disappointing.
The principal drawback of any form of phased retirement is the fact that income may not be guaranteed. By choosing to keep the majority of their fund invested at the outset, retirees must be willing to accept investment market risk and the potential that the value of their capital may fall as well as rise over time.Retirees also need to be aware that over time, with increased longevity, annuities are gradually getting more expensive. While there are variations in price over time the cost of an annuity is likely to get more expensive. The retiree on a phased retirement plan buying annuities may find that more of their fund is required to deliver the same level of annuity income in subsequent years.
For these reasons, phased retirement plans are far more suitable for retirees with larger retirement pots than those who need all their pension savings immediately with the security of a guaranteed income. For these savers the option of traditional annuities is still likely to be the best choice.
It is important to realise that if phased retirement is being used, tax free cash is limited to 25% of each phased amount, as it is used. Tax free cash based on the whole pension fund at outset cannot be taken initially while leaving the remaining funds to be phased over time.
The demand for phased retirement, particularly income drawdown has, however, significantly increased in recent years.
Phased retirement can be taken by any retiree over the age of 50 (55 from 2010). While plans are available for pensions pots from around £75,000, it is generally best suited for savers with significantly larger retirement funds.
It is particularly suitable for people who want to gradually withdraw from the workplace over a period of time rather than fully retire on a single day as it allows a smaller income to be taken in the early years to supplement other sources of income.
Phased retirement also works well for some people taking earlier retirement on a personal pension fund where they have other sources of income which will become available at an older age; for example while they are waiting for a separate defined benefit company pension to come into payment or for the state old age pension.
People can also use the flexibility of phased retirement to vary their income as they need it - while preserving retirement assets for the future
Phased retirement, either through income drawdown or the deferred purchase of annuities provides retirement savers with considerably greater flexibility over traditional annuities. It is likely that demand for this type of product will continue to increase in the future.
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